7 Welfare effectsForeign loss due to drop in exports equal to area D (trade volume effect).Foreign loss due to drop in border price equal to area B (border price effect, a.k.a., ToT effect).Net effect on Foreign = -D-B.Home loss equal to area -A-C (trade volume drops and price rises).Home gain due to drop in border price and tariff revenue equal to area A+B.Net effect on Home = -C+B.World welfare change is -D-C.If Home gains (-C+B>0) it is because it exploits foreigners by ‘making’ them pay part of the tariff (i.e. area B).

8 Distributional consequencesHome consumers lose area E+C2+A+C1Home producers gain EHome tariff revenue: A+B.Net change = B-C2-C1 (this equals B-C in left panel).Net effect can be positive or negative.Tariffs imposed because they benefit domestic producers who are often organized and politically influentialThis comes at a cost to domestic consumers and to foreignersIf Foreign retaliates and also imposes a tariff, everyone losesWith reciprocity, protectionism is not a zero-sum game

10 Preferential Trade LiberalizationPrevious analysis used 2 countries only: Home and ForeignEuropean integration is discriminatory (or preferential) and its analysis requires at least three countries:At least two integrating nations.At least one excluded nation.MD-MS diagram must to allow for two sources of imports.

13 Discriminatory unilateral liberalizationAssume Home removes T on imports only from Partner.This liberalization shifts up MS (as with MFN tariff) but not as far since it applies only to one half of imports.Shifts up MS to half way between MS (free trade) and MS (MFN tariff)More complex, kinked MS curve with PTA.If price falls below Pa, RoW will export zero.

19 Analysis of a Customs UnionEuropean integration involved a sequence of preferential liberalisations, all of them reciprocal:Both Home & Partner drop T on each other’s exports.Need to address the 3-nation trade pattern.Example: each country produces 3 goods, exports 2 and imports 1

20 Analysis of a Customs UnionHome and Partner eliminate T on their mutual tradeBoth impose T on trade with RoWHome-Partner CU has Common External Tariff (CET) equal to TAnalysis is simply a matter of recombining results from the unilateral preferential case.In market for good 1, analysis is identical.In market for good 2, Home plays the role of Partner and Partner plays role of Home.

28 Institutions Trade policy is an exclusive prerogative of the EU.Customs Union requires agreement.Commission has responsibility for negotiatingTrade Commissioner.Council of Ministers sets “Directives for Negotiation,” accepts/rejects final deal.Commission in charge of surveillance and enforcement of 3rd nation commitments.Trade disputes with US, China, etc.

29 EU External Trade PolicyEU has special arrangements with 139 nations; often more than one per partner. Each can be very complex.